Following is an e-mail I received from a
Saskatchewan cabdriver who has been tuning in our website to learn about
economics and whatever else strikes our fancy. My response follows his
letter:

Dear Mr Wanniski: Greetings from Saskatoon Sask, where it is
presently -35 degrees, good news for us cab drivers. Anyhow, while watching
CNBC this afternoon, the talk seems to be about if, or by how much, the Fed is
going to raise interest rates at its next meeting. I believe the gold price is
down around $350, so how can there be inflation fears? Are they all operating
from the assumption that inflation is caused by too much
prosperity?

Also, our papers here recently have been writing about the
improved Canadian trade surplus, and reporting it as if this is the best thing
since sliced bread. I remember reading in Mr. Bartley's book about his meeting
with the Mexican Finance minister who reported that since the ejido
reforms Mexico had seen capital inflows of $16 billion, to which Mr. Bartley
replied "then you must have a $16 billion trade deficit." If I understand this
correctly, therefore, the amount of the Canadian trade surplus is matched by
that amount of capital leaving the country? How is this good? And if you could
add a quick note about the benefits/detriments of inflation-indexed bonds.
Thank you for your time, and keep up the good work on your web page, I enjoy
it a great deal. Michael E. Zilkowsky

Dear Michael: There is a
conventional view that the Fed worries about economic expansion causing a rise
in the general price level. Some of the Fed governors believe in this idea,
which is called an "inflation/employment" trade-off. It was developed when a
British economist in the 1950s observed economic expansion following a
currency devaluation, but the devaluation also being followed by inflation.
Federal Reserve Chairman Greenspan himself knows that if the price of gold is
declining, any increase in prosperity and wages will be real, not induced by
monetary excess. He should make his position clearer, but for one reason or
another he prefers to say elliptical things on this matter, keeping his
options open.

The Canadian trade surplus could either mean that Canada
is so prosperous that it has an excess of capital, and is investing it in
other countries which have not kept up with Canada's growth. Or, it could mean
Canada is going through a period where people are fearfbl of further
investments at home, for one reason or another, and is having bargain-basement
sales abroad of its most important products. Alas, I am afraid it is the
latter condition that afflicts your country. Ottawa has to sharply reduce its
capital gains tax, which is about the highest in the world, if it is to turn
its economy to genuine expansion. If it does, one of the side effects will be
a sharp reduction in its trade surplus, which will be a good thing, not a bad
thing. When Bartley was observing Mexico's trade deficit, he was commenting on
the healthiness of the capital inflow that it represented. Since then, the
Mexican government has screwed up acting upon bad U.S. advice, and it is
running a trade surplus, as is Canada, for the wrong
reason.

Inflation-indexed bonds are gimmicks, which announce to the
world that our Treasury department does not understand that the dollar is
first and foremost a unit of account, and that it represents the non-interest
bearing debt of the government. A long-term bond in a floating exchange-rate
system can run up and down against gold many times until it reaches maturity,
which means the bondholder might have to sell during a deflationary swing,
which increases the risk of holding such a bond. It is the dollar that should
be anchored to gold, which would then permit the government and private
debtors to enjoy the lowest interest rates. Alexander Hamilton would laugh at
what U.S. Treasury Secretary Bob Rubin is doing. Or maybe he would cry.